The key to Europe’s recovery
Europe’s economy is enjoying its first meaningful recovery since 2008 but it is a slow, stuttering comeback. To secure and accelerate the turnaround, policymakers should focus on how to increase lending to the real economy and fill the funding gap left by the continent’s shrinking banks.
|Alberto Gallo, Head of European Macro Credit Research, RBS|
The signs of recovery are broad-based: better growth data, a revived housing market, improving business sentiment and rising exports. Most countries are running a primary surplus and the threat of imminent downgrade no longer hangs over sovereign debt. Further afield, a gathering US recovery is underpinning European export demand and fuelling the purchase of European assets like Vodafone’s USD130 billion stake in Verizon and Microsoft’s purchase of Nokia’s mobile division.
The recovery should ease debt pressures, giving governments more time to introduce reforms and lessen austerity. We calculate that debt-to-GDP ratios could fall an extra 5 or 6 per cent in the next four years (if the pickup delivers an additional quarter point of growth, a quarter point more inflation and a half point cut in public deficits per year).
The lack of credit to European businesses, however, remains a drag on the recovery. The worst of Europe’s credit crunch may be behind us but eurozone banks remain deep in the de-leveraging process. They have cut EUR3 trillion of assets and EUR270 billion of loans to non-financial companies since last May and we think there’s more ahead. These loans will need to be replaced if the recovery is to continue.
Worse still, it is lenders from struggling peripheral Europe who are cutting the most. While bigger European banks are replenishing their capital and liquidity and returning to profitability, mid-tier periphery banks in Spain and Italy remain undercapitalised, exposed to sovereign risk and face rising bad loans. They can’t sell assets at depressed prices as this would reduce their capital ratios. But at the same time they can’t easily raise capital because investors remain concerned about their bad assets. It’s a Catch-22 situation.
There is no silver bullet, no one plan that can fill the near-EUR300 billion gap in non-financial lending. Non-bank sources of finance – such as bonds and securitisations – are filling some of the funding gap but the scale of adjustment is huge given Europe’s traditional reliance on banks – 90 per cent of the credit supply compared with 45 per cent in the US. Only a mix of support from the private and public sector can reverse the negative loop of capital flight, higher lending rates, bankruptcies and an increasing sovereign-bank nexus.
The ECB’s liquidity operations and last year’s bond-buying pledge have steadied the ship by reducing the sovereign risk hanging over banks in the periphery, while the eurozone’s new bank bail-in regime reduces states’ exposure to the fallout from potential bad banks.
Pro-active policies are now needed to restart lending. The ECB programme of bank stress tests next year promises to improve transparency across banks and potentially to encourage bidders for bank assets. That should start to plug the capital hole that is holding back business lending.
But before banks fix themselves with the ECB’s help, greater public support is needed to help finance business. The European Investment Bank needs to do more to boost lending to SMEs. It lends around EUR45 billion of new money each year (which will rise to EUR60 billion next year) but has announced new plans for another EUR55-100 billion programme.
This could partially offset the impact of deleveraging. However, public intervention from the EIB hinges on fiscal coordination and eventually on core European countries. After the September elections, we think a likely Merkel win could herald a slightly friendlier German stance to the periphery. But the risk of complacency and lack of reforms in Italy, Spain and France remains high.
A lot still has to go right to secure the recovery but so far investors are right to buy into the turnaround story.
This communication has been prepared by The Royal Bank of Scotland N.V., The Royal Bank of Scotland plc or an affiliated entity (‘RBS’). This material should be regarded as a marketing communication and has not been prepared in accordance with the legal and regulatory requirements to promote the independence of research and may have been produced in conjunction with the RBS trading desks that trade as principal in the instruments mentioned herein. This commentary is therefore not independent from the proprietary interests of RBS, which may conflict with your interests. Opinions expressed may differ from the opinions expressed by other divisions of RBS including our investment research department. This material includes references to securities and related derivatives that the firm’s trading desk may make a market in, and in which it is likely as principal to have a long or short position at any time, including possibly a position that was accumulated on the basis of this analysis material prior to its dissem nation. Trading desks may also have or take positions inconsistent with this material. This material may have been made available to other clients of RBS before it has been made available to you and regulatory restrictions on RBS dealing in any financial instruments mentioned at any time before is distributed to you do not apply. This document has been prepared for information purposes only. This document has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained herein and RBS and each of their respective affiliates disclaim all liability for any use you or any other party may make of the contents of this document. This document is current as of the indicated date and the contents of this document are subject to change without notice. RBS does not accept any obligation to any recipient to update or correct any such information. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation. RBS makes no representation and gives no advice in respect of any tax, legal or accounting matters in any applicable jurisdiction. You should make your own independent evaluation of the relevance and adequacy of the information contained in this document and make such other investigations as you deem necessary, including obtaining independent financial advice, before participating in any transaction in respect of the securities referred to in this document. This document is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. The information contained herein is proprietary to RBS and is being provided to selected recipients and may not be given (in whole or in part) or otherwise distributed to any other third party without the prior written consent of RBS. RBS and its respective affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. This marketing communication is intended for distribution only to major institutional investors as defined in Rule 15a-6(a)(2) of the U.S. Securities Act 1934 (excluding documents produced by our affiliates within the U.S.). Any U.S. recipient wanting further information or to effect any transaction related to this trade idea must contact RBS Securities Inc., 600 Washington Boulevard, Stamford, CT, USA. Telephone: +1 203 897 2700. In Singapore, this marketing communication is intended for distribution only to institutional investors (as defined in Section 4A(1) of the Securities and Futures ct (Cap. 289) of Singapore). In Hong Kong, this marketing communication is intended for distribution only to Professional Investors (as defined in Schedule 1 of the Securities and Futures Ordinance of Hong Kong).
Issuers mentioned in any material may be investment banking clients of RBS Securities Inc. and RBS Securities Inc. may have provided in the past, and may provide in the future, financing, advice, and securitization and underwriting services to these clients in connection with which it has received or will receive compensation. Accordingly, information included in or excluded from this material is not independent from the proprietary interests of RBS Securities, Inc., which may conflict with your interests.
For further information relating to materials provided by RBS, please view our RBSMarketplace Terms and Conditions: RBSM Terms and Conditions
The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. The Royal Bank of Scotland plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal Bank of Scotland N.V., established in Amsterdam, The Netherlands. Registered with the Chamber of Commerce in The Netherlands, No. 33002587. Authorised by De Nederlandsche Bank N.V. and regulated by the Authority for the Financial Markets in The Netherlands.
The Royal Bank of Scotland plc is in certain jurisdictions an authorised agent of The Royal Bank of Scotland N.V. and The Royal Bank of Scotland N.V. is in certain jurisdictions an authorised agent of The Royal Bank of Scotland plc.
Copyright © 2013 The Royal Bank of Scotland plc. All rights reserved. This communication is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any purpose without The Royal Bank of Scotland plc’s prior express consent.
Copyright © 2013 RBS Securities Inc. All rights reserved. RBS Securities Inc. member FINRA (http://www.finra.org) / SIPC (http://www.sipc.org), is a subsidiary of The Royal Bank of Scotland plc. RBS is the marketing name for the securities business of RBS Securities Inc.